CIMB Research upgrades gloves sector as risk-reward profile improves

The worst is over for the sector as the glove makers are poised to record sequentially stronger earnings.

KUALA LUMPUR: CIMB Equities Research has upgraded the glove manufacturing sector to Overweight as its risk-reward profile improves and earnings outook improve.

It said on Wednesday the external environment with the strengthening US$ favours glove manufacturers; the sector’s supply-demand dynamics are improving.

“Ramp-up in capacity still a concern, but glove makers have collectively stepped up efforts to stagger incoming new capacity to alleviate price competition. 

"Upgrade to Overweight on better supply-demand dynamics and favourable US$,” it said.

CIMB Research said following the US presidential elections on Nov 8, the ringgit has significantly underperformed most regional currencies. 

Overall, this is positive for glove manufacturers given the export-orientated nature of the business and that over 90% of their receipts are in US$.

“Moving into 2017, we expect the US$ to strengthen further given the potential of further US Fed rate hikes and bond fund outflows. This will lead to a more conducive environment for glove makers to operate in, in our view,” it said.

The sharper depreciation of the ringgit against the US$ compared with other glove producing countries will increase the competitiveness of Malaysia’s glove sector. 

“Hence, we expect a pick-up in glove exports, leading to better supply-demand dynamics. This should ease price competition as the additional export demand takes up the excess capacity that led to the oversupply situation in 9M16,” it said.

CIMB Research pointed out that after three consecutive quarters of decline in average selling prices (ASPs) due to pricing competition, ASPs for glove makers have started to stabilise, with promising signs of a gradual increase. 

Although the bulk of the ASP increase stemmed from the recent uptick in latex prices, we expect glove makers to record margin expansion as the net impact from the strengthening US$ offsets the increase in latex prices.

It noted that although the sector's aggressive capacity ramp-up over the next two to three years is a concern, glove makers have committed to taking preventive actions to mitigate any oversupply situation. 

For instance, Top Glove and Hartalega have highlighted plans to begin commercial production from their new lines on a more gradual basis, depending on market supply-demand dynamics. 

As for Kossan, it may revamp its older lines, offsetting its new incoming capacity if the price competition persists.

“We believe the worst is over for the sector as the glove makers are poised to record sequentially stronger earnings. Given the improved supply-demand dynamics and a more favourable operating environment due to the weak RM, we upgrade the sector to Overweight. 

“We think investors should focus on companies that are key beneficiaries of a strong US$, like Top Glove. We also like Supermax for its relatively cheaper valuations vs. its peers. Key downside risk to our call: sharp strengthening of the ringgit,” it added.